The provision of efficient and sound mechanisms to protect depositor’s funds, protect safeguard banks from faltering, and maintain the financial stability of the banking system are essential, given the critical role banks play in impacting the macro-economy. Therefore, bank’s capacity to operate efficiently within an economy depends on the extent to which they meet their financial obligations, and thus earn depositors’ confidence and increased placement.
The failure of a bank and its inability to meet the claims of depositors may threaten financial stability and become ominous of an acute financial crisis within the banking system leading to a decline in public confidence in the performance of the entire banking system. To avoid such a crisis, state authorities establish a “deposit insurance system” to serve as a major component of an effective financial safety net to counter future crises facing the banks. The need for such a system increases with the rising transition towards the open-door economy model, and the globalisation of banking as banks started to accept deposits and offer services across borders. As a result, a financial crisis could become contagious and spread from one country to the other.
A “deposit insurance system” is a mechanism established by governments through laws and regulations and intended to protect depositors these (particularly with small accounts) against the loss of their deposits in case of a bank failure, thereby safeguarding the financial stability of the banking system as a whole and promoting savings and economic growth.